A Comparative Study of Credit Scores in association with Fannie Mae Loan Default Patterns: 2007 vs. 2019

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Introduction:

Making wise selections in the mortgage business requires an understanding of past loan default trends. We examine the loan default rates that Fannie Mae bought in the fourth quarters of 2007 and 2019 in this paper. Our objective is to obtain insights from the credit score data that help direct strategic decision-making by examining variables like borrower characteristics and economic situations and visualising important indicators.

Findings:

Our analysis reveals notable differences in default trends between 2007 and 2019. In 2007, during the peak of the financial crisis, default rates were significantly higher compared to 2019. 1 This difference is evident across various borrower groups and loan characteristics. For instance, loans with higher loan-to-value ratios and lower credit scores experienced more defaults in 2007, reflecting the impact of sub-prime lending practices and deteriorating economic conditions.

Media reports from the time support our findings. According to The Wall Street Journal, the subprime mortgage crisis led to a surge in default rates, particularly among borrowers with lower credit scores and riskier loan structures (Brooks and Ford, 2007). Not only was the default rate high, it was nearly nine times the 23-year average of 0.014. Similarly, CNBC (“Subprime Debacle Traps Even Very Credit-Worthy,” 2007) reported on the widespread impact of the housing market crash, highlighting the correlation between high loan-to-value ratios 6 and increased default rates.

Observing 6 in 2007, first-time homebuyers were more likely than repeat buyers to have a greater loan-to-value ratio. For both first-time and seasoned homebuyers, the most typical loan-to-value ratio ranged from 75% to 100%. On the other hand, compared to recurrent purchasers, a notably greater proportion of first-time homebuyers had a loan-to-value ratio over 75%. The possible reasoning behind the same was that lenders were more inclined to provide easy credit prior to the 2008 financial crisis, particularly sub-prime mortgages with low down payments. First-time homeowners may have had an easier time qualifying for mortgages with larger loan-to-value ratios as a result of this. Due to their eagerness to enter the property market, first-time home-buyers may have been more prone to take advantage of these easy lending choices.

To support this argument it can be evidently seen in 2 where credit scores for borrowers in 2007, is less aggressively skewed, than 2019, and regardless the low credit scores people received mortgages conveniently as a result of poor practices by the banks 5. The financial crisis led to mass unemployment and fall of the average credit score during the 2007-2008 period. Consequently the financial framework must have undergone a restructuring to allow people to rebuilt their credit score in the coming year. In 2019 more people have high scores that can be categorized as “very good” or “excellent” (Equifax).

Leading us back to the loan to value argument for 2019, we see the trend reversed 7. First-time home-buyers had lower loan-to-value ratios than repeat buyers. Either this suggests that the credit practices we made more strict or the borrower behavior experienced a shift. Credit score category association to default rates ?? however have remained the same where buyers in Poor, Fair and Good categories in 2007 and 2019 have had the most default rates.

Conversely, in 2019, default rates were generally lower 1, indicating a more stable market environment and improved borrower credit profiles. Forbes discussed the positive trends in the mortgage market, attributing lower default rates to stricter lending standards and a healthier economy (Richardson, 2021). Additionally, Forbes reported on the record-low mortgage delinquency rates in 2019, further supporting our analysis of improved borrower credit profiles and market stability.

Regional analysis of default rates in US states show that buyers were more likely to default on their loans if they resided near either coasts of the country during the financial crisis of 2008 8. The likely however was very low and rather opposite as the housing prices in the same states rose drastically, inversely increasing the demand for homes in in-land states 9.

Conclusion:

Finally, our analysis emphasises how crucial market dynamics and historical context are to comprehending loan default trends for loans that were acquired by Fannie Mae. Due to subprime lending practices and unstable economic conditions, the financial crisis of 2007 resulted in higher default rates; nevertheless, the more favourable conditions of 2019 led to lower default rates and better borrower credit profiles. Stakeholders may improve risk management tactics, streamline underwriting procedures, and adjust to changing market conditions in the mortgage sector by utilising the information from our investigation.

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Works cited:

Articles. Equifax. (n.d.). https://www.equifax.com/personal/education/credit/score/articles/-/learn/credit-score-ranges/

Brooks, R., & Ford, C. M. (2007, October 11). The United States of subprime - WSJ. https://www.wsj.com/articles/SB119205925519455321

Brooks, R., & Simon, R. (2007, December 3). Subprime debacle traps even very credit-worthy - WSJ. https://www.wsj.com/articles/SB119662974358911035

Chang, D. (2023, October 26). The Subprime Mortgage Crisis of 2008: A beginner’s guide. The Motley Fool. https://www.fool.com/the-ascent/mortgages/subprime-mortgage-crisis/#:~:text=The%20subprime%20mortgage%20crisis%20occurred%20from%202007%20to%202010%20after%20the%20collapse%20of%20the%20U.S.%20housing%20market.,their%20loans.

Kenton, W. (2022, April 16). What was the subprime meltdown? what happened and consequences. Investopedia. https://www.investopedia.com/terms/s/subprime-meltdown.asp#:~:text=The%20subprime%20meltdown%20was%20the%20sharp%20increase%20in%20high-risk,in%202007.

McArthur, C., & Edelman, S. (2024, March 22). The 2008 housing crisis. Center for American Progress. https://www.americanprogress.org/article/2008-housing-crisis/#:~:text=In%202007%2C%20during%20the%20peak%20of%20the%20financial%20crisis%2C,to%202019.

Richardson, B. (2021, July 14). Mortgage market is finally turning a corner on delinquency rates. Forbes. https://www.forbes.com/sites/brendarichardson/2021/07/13/mortgage-market-is-finally-turning-a-corner-on-delinquency-rates/?sh=6a5a0482266c

Figure Appendix

## `geom_line()`: Each group consists of only one observation.
## ℹ Do you need to adjust the group aesthetic?
## `geom_line()`: Each group consists of only one observation.
## ℹ Do you need to adjust the group aesthetic?

Figure 1: Time Series Plot of Default Rates (2000-2023)

Figure 2: Exploratory analysis of credit scores and its association with default rate (2007 vs. 2019).

Figure 3: Exploratory analysis of credit scores and its association with default rate (2007 vs. 2019).

Figure 4: Exploratory analysis of credit scores and its association with default rate (2007 vs. 2019).

Figure 5: Original unpaid principal balance by Credit Score Range for 2007 and 2019

Figure 6: Original Loan to Value Ratio Classified by First-Time Homebuyer (2007)

Figure 7: Original Loan to Value Ratio Classified by First-Time Homebuyer (2019)

Figure 8: Default Rate by State in 2007

Figure 9: Default Rate by State in 2019